How is my credit score calculated?Submitted by Janis Bellman, Hon. B. Comm on July 5th, 2018
From the moment you apply for that first credit card or loan and your credit history commences, financial institutes and lenders will eagerly track your credit score. This score impacts almost every facet of Canadian’s lives – it determines your ability to rent an apartment, buy your own home or vehicle and qualify for loans at reasonable interest rates. In certain circumstances it can even determine future employment opportunities!
Despite the massive ramifications of this three digit number, many Canadians are completely unaware of their credit score.
So, first of all, what is a credit score?
Simply put, your score is a number that predicts how likely an individual is to repay debt. The number – which will sit between 300 and 900 – represents the probability that a lender will receive the money originally lent to an individual. Therefore, TransUnion, one of the two Canadian credit-monitoring firms, reports that a score “between 800 to 900 is ‘very good’ and 750 to 800 is considered ‘good.’ People with a score below 650 may have trouble getting new credit.” 1
So now we know – earn a credit score north of 750 and life should be swell! However, in order to build strong credit we need to understand how reporting bureaus calculate these scores.
This is often the greatest determinant of someone’s credit score. Lenders will check how consistently a person has paid off previous debts in order to forecast the level of risk associated with lending to them in the future. The payments tracked extend to “your credit cards, line of credit, car loan, personal loan, student loan, cell phone on contract and any other regular debts you have.” 2
Therefore, if you're late or entirely miss a debt repayment, be prepared for a hit to your credit score. More significantly, if you have previously faced foreclosure, bankruptcy or allowed any debts to go into collection, then don’t be surprised when looking at a less-than-pretty number.
Lenders also take into account the recency of your payment history. So if you spent frivolously when you first received a credit card don’t panic! Credit mismanagement from years past will become more inconsequential as long as “you get the account back in good standing and resume making on-time payments.” 3
Credit history and credit mix
A longer credit history gives lenders a greater sample size to observe an individual’s credit tendencies. As such, a teenager paying off their first credit card payments will not have as high of a score as a middle-aged professional who has yet to make a late payment. It takes years to demonstrate responsible credit decisions.
Creditors also value individuals that have balanced multiple lines of credit for numerous years. Relying on a credit card, auto-loans, student loans and a mortgage indicates greater financial responsibility than having “five credit cards and a couple of unsecured loans.” 4
Credit amount being used
It is essential for lenders to know how much debt you currently owe as well as how close you you are to maxing out your credit. This snapshot of an individual’s immediate credit situation offers a glimpse into how flexible they are in making debt repayments.
For example, consistently sitting at around 80% of your credit limit is deemed risky by lenders as your ability to make payments would be hindered given a sudden change in income or other extenuating circumstance.
However, do not avoid using your credit card entirely! Regular payments are viewed more positively than zero debt as “it shows a pattern of behaviour.” 5
Recency of credit applications
Applying for a new credit card while awaiting acceptance for a loan from the bank or mortgage is not a good look. Although this application may be completely coincidental, lenders will mark this as a red flag. Instead of requesting multiple types of credit simultaneously, open only one first and begin to pay it off to improve your score.
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